CHAPTER 15

Equity
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe the corporate form 3. Explain the accounting and
and the issuance of shares. reporting issues related to
dividends.
2. Explain the accounting and
reporting for treasury shares. 4. Indicate how to present and
analyze equity.

15-1
 Corporate Capital

Three primary forms of business organization.

Special characteristics of the corporate form:

1. Influence of corporate law.
2. Use of the share system.
3. Development of a variety of ownership interests.
4. Limited liability.

15-2
 Corporate Law

⚫ Corporation must submit articles of incorporation to the

appropriate governmental agency for the country in which
incorporation is desired.
⚫ Governmental agency issues a corporation charter.
⚫ Advantage to incorporate where laws favor the corporate form
of business organization.

15-3
 Share System

In the absence of restrictive provisions, each share carries the

following rights:
1. To share proportionately in profits and losses.
2. To share proportionately in management (the right to vote
for directors).
3. To share proportionately in assets upon liquidation.
4. To share proportionately in any new issues of shares of
the same class—called the preemptive right.

15-4
 Variety of Ownership Interests

Ordinary shares represent the residual corporate interest that

⚫ Bears ultimate risks of loss.

⚫ Receives the benefits of success.

⚫ Not guaranteed dividends nor assets upon dissolution.

Preference shares are created by contract, when shareholders’

sacrifice certain rights in return for other rights or privileges,
usually dividend preference.

15-5
 Components of Equity

Equity is often subclassified on the statement of financial

position into the following categories
1. Share capital.
2. Share premium.
3. Retained earnings.
4. Accumulated other comprehensive income.
5. Treasury shares.
6. Non-controlling interest (minority interest).

15-6
 Components of Equity

Ordinary Shares
Account
Contributed
Share Premium
Capital Account
Preference Shares
Account

Two Primary
Sources of Retained Earnings
Account
Equity Assets –
Liabilities =
Less: Equity
Treasury Shares
Account

15-7 LO 1
 Components of Equity

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

15-8
 Components of Equity

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

15-9
 Components of Equity

Following approval by shareholders of the Company at the 2020 EGM,

the Company issued 2,503,355,631 new ordinary shares at HK$4.68
each on 10th August 2020, and 195,000,000 preference shares at
HK$100 each and 416,666,666 warrants on 12th August 2020.

15-10
 EQUITY

Equity is often subclassified on the statement of financial

position into the following categories
1. Share capital. What do we call them under
U.S. GAAP?
2. Share premium.

3. Retained earnings.

4. Accumulated other comprehensive income.

5. Treasury shares.

6. Non-controlling interest (minority interest).

15-11 LO 2
 EQUITY
a. Generally, the amount of ordinary shares
repurchased. 1. Share capital.

b. The excess of amounts paid-in over the par or 2. Share premium.

stated value.
3. Retained earnings.
c. A portion of the equity of subsidiaries not
4. Accumulated other
owned by the reporting company.
comprehensive
d. The par or stated value of shares issued. It income.
includes ordinary shares and preference
5. Treasury shares.
shares.
6. Non-controlling interest
e. The corporation‘s undistributed earnings.
(minority interest).
f. The aggregate amount of the other
comprehensive income items.

15-12 LO 2
 In-class Exercise

East Point City ( 東 港 城 ) has the following equity balances at

December 31, 2022.

Share capital—ordinary, HK$ 5 par value HK$ 510,000

Treasury shares HK$ 90,000
Retained earnings HK$ 2,340,000
Share premium—ordinary HK$ 1,320,000

Prepare East Point City’s December 31, 2022, equity section in the
statement of financial position.

15-13 LO 1
 Issuance of Shares

Accounting problems involved in the issuance of shares:

1. Par value shares.

2. No-par shares.

3. Costs of issuing shares.

4. Shares issued in combination with other securities.

15-14 LO 1
 Issuance of Shares

Par Value Shares

Par value: The stated value on a stock certificate.

Corporations maintain accounts for:

◆ Preference Shares or Ordinary Shares.

◆ Share Premium.

Does par value of stock always remain unchanged?

15-15 LO 1
 Issuance of Shares

Illustration: Video Electronics Corporation is organized with

10,000 ordinary shares authorized with a €6 par value. If Video
Electronics issues 500 shares for cash at €10 per share, it
makes the following entry.

Cash (500 x €10) 5,000

Share Capital—Ordinary (500 x €6) 3,000
Share Premium—Ordinary 2,000

15-16 LO 3
 No-Par Shares
Reasons for using no-par shares:
◆ Avoids potential liability in the event of liquidation.
◆ For example, if company ABC issues 1,000 shares of stock
with a par value of $5, then the minimum amount of equity
that should be generated by the sale of those shares is
$5,000. If stock price goes down and all 1,000 shares are
purchased below par, say for $3, the company will generate
only $3,000 in equity. If the business goes under and cannot
meet its financial obligations, shareholders could be held
liable for the $2-per-share difference between par and the
purchase price.

◆ Avoids confusion over recording par value versus fair

market value.
15-17 LO 1
 Issuance of No-Par Shares

Illustration: Video Electronics AG is organized with 10,000

ordinary shares authorized without par value. If Video
Electronics issues 500 shares for cash at €10 per share, it
makes the following entry.

Cash 5,000
Share Capital—Ordinary 5,000

Video Electronics issues another 500 shares for €11 per share.

Cash 5,500
Share Capital—Ordinary 5,500

15-18 LO 1
 Issuance of No-Par Shares

Illustration: Some countries require that no-par shares have a

stated value. If a company issued 1,000 of the shares with a €5
stated value at €15 per share for cash, it makes the following
entry.

Cash 15,000
Share Capital—Ordinary 5,000
Share Premium—Ordinary 10,000

15-19 LO 1
 Issuance of Shares

Costs of Issuing Stock

Direct costs incurred to sell shares, such as
◆ underwriting costs,
◆ accounting and legal fees,
◆ printing costs, and
◆ taxes,
should reduce the proceeds received from the sale of the
shares.

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 Issuance of Shares

Illustration: Video Electronics Corporation is organized with

10,000 ordinary shares authorized without par value. If Video
Electronics issues 500 shares for cash at €10 per share, and
incurs underwriting costs of €1,000, it makes the following entry.

Cash (500 x €10 – €1,000) 4,000

Share Capital—Ordinary 4,000

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 Issuance of Shares

Shares Issued with Other Securities

Two methods of allocating proceeds:

◆ Proportional method.

◆ Incremental method.

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 Shares Issued with Other Securities
Illustration: Ravonette Corporation issued 300 shares of $10 par
value ordinary shares and 100 shares of $50 par value preference
shares for a lump sum of $13,500. The ordinary shares have a market
value of $20 per share, and the preference shares have a market
value of $90 per share.

Number Amount Total Percent

Ordinary shares 300 x $ 20.00 = $ 6,000 40%
Preference shares 100 x 90.00 9,000 60%
Fair Market Value $ 15,000 100%

Allocation: Ordinary Preference

Issue price $ 13,500 $ 13,500 Proportional
Allocation % 40% 60% Method
Total $ 5,400 $ 8,100

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 Shares Issued with Other Securities
Illustration: Ravonette Corporation issued 300 shares of $10 par
value ordinary shares and 100 shares of $50 par value preference
shares for a lump sum of $13,500. The ordinary shares have a market
value of $20 per share, and the preference shares have a market
value of $90 per share.

Journal entry (Proportional method):

Cash 13,500
Share Capital—Preference (100 X $50) 5,000
8,100
Share Premium—Preference 3,100
Share Capital—Ordinary (300 X $10) 3,000
5,400
Share Premium—Ordinary 2,400

15-24 LO 1
 Shares Issued with Other Securities
Illustration: Ravonette Corporation issued 300 shares of $10 par value
ordinary shares and 100 shares of $50 par value preference shares for a
lump sum of $13,500. The ordinary shares have a market value of $20
per share, and the value of preference shares are unknown.

Number Amount Total

Ordinary shares 300 x $ 20.00 = $ 6,000
Preference shares 100 x -
Fair Market Value $ 6,000

Allocation: Ordinary Preference

Issue price $ 13,500 Incremental
Ordinary (6,000) Method
Total $ 6,000 $ 7,500

15-25 LO 1
 Shares Issued with Other Securities
Illustration: Ravonette Corporation issued 300 shares of $10 par value
ordinary shares and 100 shares of $50 par value preference shares for a
lump sum of $13,500. The ordinary shares have a market value of $20
per share, and the value of preference shares are unknown.

Journal entry (Incremental):

Cash 13,500
Share Capital—Preference (100 X $50) 5,000
7,500
Share Premium—Preference 2,500
Share Capital—Ordinary (300 X $10) 3,000
6,000
Share Premium—Ordinary 3,000

15-26 LO 1
 CPA Question (Poll)

On July 1, 2019, Nall Co. issued 2,500 shares of its €10 par
ordinary shares and 5,000 shares of its €10 par convertible
preference shares for a lump sum of €125,000. At this date
Nall’s ordinary shares were selling for €24 per share and the
convertible preference shares for €18 per share. The amount
of the proceeds allocated to Nall’s preference shares should be
A. €62,500.
B. €75,000. [(18*5000)/(24*2500 + 18*5000)]*125,000
ANSWER B
C. €90,000.
D. €68,750.
15-27 LO 1
 In-class Exercise

Louis Vuitton issues 500 shares of €10 par value ordinary shares and
100 shares of €100 par value preference shares for a lump sum of
€100,000.

• Prepare the journal entry for the issuance when the fair value of
the ordinary shares is €168 each and fair value of the preference
shares is €210 each. (Round to the nearest euro.)

• Prepare the journal entry for the issuance when only the fair value
of the ordinary shares (€170 per share) is known.

15-28 LO 1
 Preference Shares
Preference shares: a special class of shares that
possess certain preferences of features not
possessed by ordinary shares.

Features often associated with preference shares.

1. Preference as to dividends.

2. Preference as to assets in the event of liquidation.

3. Convertible into ordinary shares.

4. Non-voting.

The accounting for preference shares at issuance is similar

to that for ordinary shares.
15-29 LO 1
 Components of Equity

Following approval by shareholders of the Company at the 2020 EGM,

the Company issued 2,503,355,631 new ordinary shares at HK$4.68
each on 10th August 2020, and 195,000,000 preference shares at
HK$100 each and 416,666,666 warrants on 12th August 2020.

15-30
 PREFERENCE SHARES

Miscellaneous facts about preference shares

◆ A preference to dividends does not assure the payment of
dividend.
◆ A company often issues preference shares (instead of
debt) because of a high debt to equity ratio.

15-31 LO 5
 Cathay’s Recapitalization 2020
Danny Lee
Published: 9:12am, 9 Jun, 2020

As part of the deal, the government will create a new company called Aviation
2020 to buy HK$19.5 billion (US$2.5 billion) in preferential shares – equity with
restricted voting rights

15-32
 PREFERENCE SHARES

◆ Cumulative Preference Shares

➢ If a corporation fails to pay a dividend in any year, it
must make it up in a later year before paying any
dividends to ordinary shareholders.
➢ Dividend in arrears: passed dividend that the
corporation fails to declare at the normal date for
dividend action.
➢ More marketable than non-cumulative preference
shares.

15-33 LO 5
 Cathay’s Recapitalization 2020
Ends/Wednesday, February 22, 2023
Issued at HKT 14:20

It has been reported that Cathay Pacific Airways Limited (Cathay Pacific), which received
an injection of $27.3 billion of public money from the Government on the grounds of
"maintaining Hong Kong's status as an international aviation hub" in June 2020, has
announced its fifth deferral of payment of preference share dividends to the Government,
and the cumulative amount of dividends in arrears has totalled $1.46 billion. Meanwhile,
Cathay Pacific has also expressly pointed out that there has been no timetable for repaying
debts to the Government.
Under the investment agreement, the Cathay Group shall pay dividends to the
Government, the holder of the preference shares, every six months at a step-up rate until
the redemption of all preference shares. The dividend rate per annum is three per cent for
the first three years, five per cent for year four, seven per cent for year five, and nine per
cent for the remaining years. Any delay by the Cathay Group in redeeming the preference
shares from the Government would result in a gradual increase in the financing costs of
the company. This arrangement is aimed at encouraging the Cathay Group to redeem the
preference shares at the earliest possible time having regard to its business and
operational considerations. The agreement further provided that the Cathay Group may at
its discretion defer the payment of the preference share dividends. That said, any
dividends in arrears shall be entitled to additional dividends at the prevailing dividend rate,
and the Group shall be ultimately responsible for paying all dividends, including the
additional dividends, to the Government. During the deferral of dividend payable on the
preference shares, the Cathay Group shall not distribute dividends on its ordinary shares.
15-34
 PREFERENCE SHARES

◆ Convertible Preference Shares

➢ Allow shareholders to convert the preference
shares into ordinary shares at a predetermined
ratio, usually any time after a predetermined date.

15-35 LO 5
 Convertible Preference Shares
Illustration:
Imagine you bought 100 shares of convertible preferred stock in XYZ
corporation. The preferred stock cost you $500 per share, so your
total investment is $50,000. The conversion privilege allows you to
convert each share of preferred stock into 50 shares of common
stock.
Your "cost" of converting to common is $10 per share ($500
preferred stock divided by 50 shares of common stock = $10 cost
per share in the event of conversion).
If the common stock is less than $10, your convertible preferred
rights aren't worth much. If the common stock is $10 or more, your
conversion rights can be valuable.
15-36 LO 5
 Preference Shares

Illustration: Bishop plc issues 10,000 shares of £10 par value

preference shares for £12 cash per share. Bishop records the
issuance as follows:

Cash 120,000
Share Capital—Preference 100,000
Share Premium—Preference 20,000

15-37 LO 1
 Dual-class Shares

Dual-class Shares
◆ Within ordinary shares, companies might issue different
classes of shares that can differ in voting rights and/or
dividend payments.

◆ Dual class structure provides a portion of the

shareholders the ability to control majority voting power
with a relatively small percentage of total equity.

◆ Supporters and Opponents.

15-38 LO 5
15-39 LO 5
 REINHARDT KRAUSE 05/29/2020

Not all IPO stocks are created equal; just ask Shopify (SHOP) and numerous other tech
companies such as Facebook (FB) and Google-parent Alphabet (GOOGL). Thanks to a
system known as dual-class shares, they all stayed safe during the coronavirus stock
market tumble in March.
Though many issues are on hold amid the coronavirus emergency, a debate continues to
brew over the use of dual-class. Supporters contend dual-class shares give visionary
founders like Shopify Chief Executive Tobias Lutke the same long-term control that
Facebook's Mark Zuckerberg has used to build a social media powerhouse. Critics worry
about creating permanent corporate monarchs that don't answer to shareholders.
15-40
15-41
 LEARNING OBJECTIVE 2
Reacquisition of Shares Explain the accounting and
reporting for treasury shares.

Companies purchase their outstanding shares to:

1. Increase earnings per share and return on equity.
2. Provide shares for employee compensation contracts or to
meet potential merger needs.
3. Thwart takeover attempts or to reduce the number of
shareholders.
4. Make a market in the shares.

15-42 LO 2
15-43
 Stock Buybacks: Destroy Capital?

15-44
 Such a nefarious use of corporate funds makes for great headlines. But
these claims are very rarely backed up by large-scale evidence, and
often driven by a misunderstanding of how buybacks actually
operate. First, firms allocate funds to investment based on the
opportunities that are available. If they have spare cash left over after
taking all value-creating investment opportunities then they may use it
for buybacks. Repurchases allow shareholders to reallocate funds to
young, high-growth firms that are screaming out for a cash injection.
15-45
 Reacquisition of Shares

Treasury Shares

◆ After reacquiring shares, a company may either retire

them or hold them in the treasury for reissue. If not
retired, such shares are referred to as treasury shares.

Are Treasury Shares

Assets?

15-46 LO 4
 Treasury Shares

15-47 LO 4
 Reacquisition of Shares

Purchase of Treasury Shares

Two acceptable methods:
◆ Cost method (more widely used).

◆ Par (stated) value method.

Treasury shares reduce equity.

15-48 LO 2
 Purchase of Treasury Shares

Illustration: Pacific Company issued 100,000 shares of $1 par

value ordinary shares at a price of $10 per share. In addition, it
has retained earnings of $300,000.

ILLUSTRATION 15.4
Equity with No Treasury Shares

15-49 LO 2
 Purchase of Treasury Shares

Illustration: Pacific Company issued 100,000 shares of $1

par value ordinary shares at a price of $10 per share. In
addition, it has retained earnings of $300,000.
On January 20, 2020, Pacific acquires 10,000 of its shares at
$11 per share. Pacific records the reacquisition as follows.

Treasury Shares 110,000

Cash 110,000

Reduce Equity

15-50 LO 2
 Purchase of Treasury Shares

Illustration: The equity section for Pacific after purchase of the

treasury shares.

ILLUSTRATION 15.5
Equity with Treasury Shares

15-51 LO 2
 Reacquisition of Shares

Sale of Treasury Shares

◆ Above Cost

◆ Below Cost

Both increase total assets and equity.

15-52 LO 2
 Sale of Treasury Shares

Sale of Treasury Shares above Cost. Pacific acquired

10,000 treasury shares at $11 per share. It now sells 1,000
shares at $15 per share on March 10. Pacific records the
entry as follows.

Cash 15,000
Treasury Shares 11,000
Share Premium—Treasury 4,000

15-53 LO 2
 Sale of Treasury Shares

Sale of Treasury Shares below Cost. Pacific sells an

additional 1,000 treasury shares on March 21 at $8 per share,
it records the sale as follows.

Cash (1,000 * $8) 8,000

Share Premium—Treasury 3,000
Treasury Shares (1,000 * $11) 11,000

15-54 LO 2
 Sale of Treasury Shares

ILLUSTRATION 15.6
Treasury Share
Transactions in Share
Premium—Treasury
Account

Illustration: Assume that Pacific sells an additional 1,000 shares

at $8 per share on April 10.
Cash 8,000
Share Premium—Treasury 1,000
Retained Earnings 2,000
Treasury Shares 11,000

After eliminating the credit balance in Share Premium-

Treasury, the corporation debits any additional excess of
15-55
cost over selling price to Retained Earnings LO 2
 Retiring Treasury Shares

Retiring treasury shares results in

⚫ cancellation of the treasury shares and

⚫ a reduction in the number of shares of issued shares.

Retired treasury shares have the status of authorized and

unissued shares.

15-56 LO 3
 CPA Question (Poll)
At its date of incorporation, Sauder, Inc. issued 100,000 shares of
its €10 par ordinary shares at €11 per share. During the current
year, Sauder acquired 20,000 ordinary shares at a price of €16
per share and accounted for them by the cost method.
Subsequently, these shares were reissued at a price of €12 per
share. There have been no other issuances or acquisitions of its
own ordinary shares. What effect does the reissuance of the
shares have on the following accounts?

Retained Earnings Share Premium

a. Decrease Decrease
b. No effect Decrease Answer: C
c. Decrease No effect
d. No effect No effect
15-57 LO 2
 In-class Exercise
Hermès is authorized to issue 50,000 shares of $10 par value
ordinary shares. During 2022, Hermès took part in the following
selected transactions.
▪ Issued 5,000 shares at $45 per share, less costs related to the
issuance of the shares totaling $7,000.
▪ Issued 1,000 shares for land appraised at $50,000. The shares
were actively traded on a national securities exchange at
approximately $46 per share on the date of issuance.
▪ Purchased 500 treasury shares at $44 per share. The treasury
shares purchased were issued in 2021 at $40 per share.

Prepare journal entries for each transaction.

15-58 LO 2
 In-class Exercise
Longines has outstanding 40,000 shares of €5 par ordinary shares which
had been issued at €30 per share. Longines then entered into the following
transactions.
1. Purchased 5,000 treasury shares at €45 per share.
2. Resold 500 of the treasury shares at €40 per share.
3. Resold 2,000 of the treasury shares at €49 per share.
Use the following code to indicate the effect each of the three transactions,
assuming Longines uses the cost method: I = Increase; D = Decrease; and
NE = No effect.

A L E Share Retained Net

Premium Earnings Income
1
2
3
15-59 LO 2
 LEARNING OBJECTIVE 3
Dividend Policy Explain the accounting and
reporting issues related to
dividends.

Few companies pay dividends in amounts equal to

their legally available retained earnings. Why?
1. Maintain agreements with creditors.

2. Meet corporation requirements.

3. To finance growth or expansion.

4. To smooth out dividend payments.

5. To build up a cushion against possible losses.

15-60 LO 3
 Agreement with Creditors

Net Worth Covenant: COMPANY shall, at all times throughout the term of the
Loan, maintain a minimum Net Worth of at least $35,000,000.00. As used
herein, the term "Net Worth" shall mean, on any applicable date of
determination, (i) the net book value of all assets of COMPANY(excluding,
however, receivables from Affiliates, patent rights, trademarks, trade names,
franchises, copyrights, licenses, goodwill and other intangible assets), after all
appropriate deductions in accordance with Acceptable Accounting Standards
(including, without limitation, reserves for doubtful receivables, obsolescence,
depreciation and amortization), less (ii) all liabilities of COMPANY (including,
without limitation, liabilities for taxes and a fair valuation of contingent or
indirect liabilities), all as determined in accordance with Acceptable Accounting
Standards and otherwise in Lender's sole discretion.

15-61 LO 3
 Dividend Policy

15-62 LO 6
 Dividend Policy

Types of Dividends

1. Cash dividends. 3. Liquidating dividends.

2. Property dividends. 4. Share dividends.

How does each type of the dividends affect the total equity in
the corporation?

15-63 LO 3
 Dividend Policy

Cash Dividends
◆ Board of directors vote on the declaration of cash
dividends.

◆ A declared cash dividend is a liability.

Three dates:
◆ Companies do not declare
a. Date of declaration
or pay cash dividends on
b. Date of record
treasury shares. c. Date of payment

◆ Dividend on preference shares are

paid as % of par value

15-64 LO 3
 Dividend Policy

Illustration: Roadway Freight Corp. on June 10 declared a cash

dividend of 50 cents a share on 1.8 million shares payable July
16 to all shareholders of record June 24.

At date of declaration (June 10)

Retained Earnings 900,000
Dividends Payable 900,000

At date of record (June 24) No entry

At date of payment (July 16)

Dividends Payable 900,000
Cash 900,000

15-65 LO 3
 Dividend Policy

Dividend Preference
Non-Cumulative and Non-Participating Preference
Illustration: In 2022, Mason Company is to distribute €50,000 as
cash dividends, its outstanding ordinary shares have a par value
of €400,000, and its 6 percent preference shares have a par
value of €100,000.
▪ If the preference shares are noncumulative and
nonparticipating:

15-66 LO 3
 Dividend Policy

Dividend Preference
Cumulative and Non-Participating Preference Shares,
with Dividends in Arrears
Illustration: In 2022, Mason Company is to distribute €50,000 as
cash dividends, its outstanding ordinary shares have a par value
of €400,000, and its 6 percent preference shares have a par
value of €100,000.
▪ If the preference shares are cumulative and non-participating,
and Mason Company did not pay dividends on the preference
shares in the preceding two years:

15-67 LO 3
 CPA Question (Poll)

At December 31, 2018 and 2019, Plank Corp. had outstanding

2,000 shares of €100 par value 8% cumulative preference shares
and 10,000 shares of €10 par value ordinary shares. At
December 31, 2018, dividends in arrears on the preference
shares were €8,000. Cash dividends declared in 2019 totalled
€30,000. What amounts were payable on each class of stock?
Preference Shares Ordinary Shares
a. €16,000 €14,000
b. €22,000 €8,000
Answer: C
c. €24,000 €6,000
d. €30,000 €0
15-68 LO 3
 Dividend Policy

Property Dividends
◆ Dividends payable in assets other than cash.

◆ Restate at fair value the property it will distribute,

recognizing any gain or loss.

15-69 LO 3
 Dividend Policy
Illustration: Tsen, Ltd. transferred to shareholders some of its
investments (held-for-trading) in securities costing HK$1,250,000
(purchased on June 1, 2021) by declaring a property dividend on
December 28, 2021, to be distributed on January 30, 2022, to
shareholders of record on January 15, 2022. At the date of
declaration the securities have a fair value of HK$2,000,000. Tsen
makes the following entries.

At date of declaration (December 28, 2021)

Equity Investments 750,000
Unrealized Holding Gain or Loss—Income 750,000
Retained Earnings 2,000,000
Property Dividends Payable 2,000,000
15-70 LO 3
 Dividend Policy

Illustration: Tsen, Ltd. transferred to shareholders some of its

investments (held-for-trading) in securities costing HK$1,250,000
by declaring a property dividend on December 28, 2021, to be
distributed on January 30, 2022, to shareholders of record on
January 15, 2022. At the date of declaration the securities have a
fair value of HK$2,000,000. Tsen makes the following entries.

At date of distribution (January 30, 2022)

Property Dividends Payable 2,000,000

Equity Investments 2,000,000

15-71 LO 3
 CPA Question (Poll)
Farmer Corp. owned 20,000 shares of Eaton Corp. purchased in
2018 for €240,000. On December 15, 2018, Farmer declared a
property dividend of all of its Eaton Corp. shares on the basis of
one share of Eaton for every 10 ordinary shares of Farmer held by
its shareholders. The property dividend was distributed on January
15, 2019. On the declaration date, the aggregate market price of
the Eaton shares held by Farmer was €400,000. The entry to
record the declaration of the dividend would include a debit to
Retained Earnings of
A. €0.
B. €160,000. How about the net effect
on retained earnings?
C. €240,000.
D. €400,000.
Answer: D
15-72 LO 3
 Liquidating Dividends

◆ A liquidating dividend is a type of payment that a

corporation makes to its shareholders during a partial
or full liquidation.

◆ Liquidating dividend is paid out after all creditor

obligations have been settled, so the dividend payout
should be one of the last actions taken before the
business is closed.

◆ Any dividend not based on earnings reduces amounts

paid-in by shareholders.

15-73 LO 3
 Liquidating Dividends
Illustration: McChesney Mines Inc. issued a liquidating
dividend to its ordinary shareholders of £1,200,000. The cash
dividend announcement noted that shareholders should
consider £900,000 as income and the remainder a return of
capital. McChesney Mines records the dividend as follows.

At date of declaration
Retained Earnings 900,000
Share Premium — Ordinary 300,000
Dividends Payable 1,200,000

15-74 LO 3
 Liquidating Dividends
Illustration: McChesney Mines Inc. issued a liquidating
dividend to its ordinary shareholders of £1,200,000. The cash
dividend announcement noted that shareholders should
consider £900,000 as income and the remainder a return of
capital. McChesney Mines records the dividend as follows.

At date of payment

Dividends Payable 1,200,000

Cash 1,200,000

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 Share Dividends

Share Dividends
◆ Issuance by a corporation of its own shares to shareholders
on a pro rata basis, without receiving any consideration.

◆ Par value, not the fair value, is used to record the share
dividend.

◆ Share dividend does not affect any asset or liability.

◆ Journal entry reflects a reclassification of equity.

◆ Ordinary share dividend distributable reported in the equity

section as an addition to share capital—ordinary.

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 Share Dividends

Illustration: Vine plc has outstanding 100,000 shares of £1 par

value ordinary shares and retained earnings of £50,000. If Vine
declares a 10 percent share dividend, it issues 10,000 additional
shares to current shareholders. If the fair value of the shares at
the time of the share dividend is £8 per share, the entry is:

Date of declaration

Retained Earnings 10,000

Ordinary Share Dividend Distributable 10,000

How will stock price change

after distributing share dividends?
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 Share Dividends

Illustration: Vine plc has outstanding 100,000 shares of £1 par

value ordinary shares and retained earnings of £50,000. If Vine
declares a 10 percent share dividend, it issues 10,000 additional
shares to current shareholders. If the fair value of the shares at
the time of the share dividend is £8 per share, the entry is:

Date of distribution

Ordinary Share Dividend Distributable 10,000

Share Capital—Ordinary 10,000

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 Effects of Share Dividends

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 Dividend Policy

How does each type of dividends affect the

total equity in the corporation?

1. Cash dividends. 3. Liquidating dividends.

2. Property dividends. 4. Share dividends.

All dividends, except for share dividends, reduce the total

equity in the corporation.

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 Share Splits

Share Splits
◆ To reduce the market value of shares.

◆ No entry recorded for a share split.

◆ Decrease par value and increased number of shares.

ILLUSTRATION 15.13
Effects of a Share Split

15-81 LO 3
 Share Splits

https://finance.yahoo.com/quote/GOOG/history?period1=
1388534400&period2=1677628800&interval=1mo&filter=h
istory&frequency=1mo&includeAdjustedClose=true
15-82 LO 3
 Share Dividends vs. Share Splits

Share Split and Share Dividend Differentiated

A share split differs from a share dividend. How?
◆ A share split increases the number of shares
outstanding and decreases the par or stated value per
share.

◆ A share dividend,
► increases the number of shares outstanding.
► does not decrease the par value.
► increases the total par value of outstanding shares.

15-83 LO 3
 Discussion
Ortago S.A.’s €10 par ordinary shares are selling for €110 per
share. Four million shares are currently issued and outstanding.
The board of directors wished to stimulate interest in Ortago S.A
ordinary shares before a forthcoming share issue but does not wish
to distribute cash at this time. The board also believes that too
many adjustments to the equity section, especially retained
earnings, might discourage potential investors. The Board has
considered three options for stimulating interest in the shares:

1. A 20% share dividend.

2. A 100% share dividend.
3. A 2-for-1 share split.

Acting as financial advisor to the board, you have been asked to

report briefly on each option and, considering the board's wishes,
make a recommendation. Discuss the effects of each of the
foregoing options.
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 Option 1: A 20% share dividend.

Retained Earnings (€10 * 800,000) 8,000,000

Share Capital—Ordinary 8,000,000

• This option would increase the shares outstanding by 20

percent;
• Decreased market price;
• However, the reduction in Retained Earnings may
hinder Oregon Inc.’s success with the subsequent share
offer –future dividends are limited to available retained
earnings

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 Option 2: A 100% share dividend.

Retained Earnings (€ 10 * 4,000,000) 40,000,000

Share Capital—Ordinary 40,000,000

• This option would double the shares outstanding

• Decreased market price
• The reduction in Retained Earnings is great:
€ 40,000,000.

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 Option 3: A 2-for-1 share split.

• This option doubles the number of shares issued and

outstanding;
• It cuts the par value per share in half;
• Retained Earnings, Share Capital, Share Premium all
remain unchanged
• Decreased market price

To generate the greatest interest in Ortago S.A. shares

while maintaining the present balances in the equity
section of the statement of financial position, you should
opt for the 2-for-1 share split.

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 CPA Question (Poll)
On December 31, 2018, the equity section of Arndt, Inc., was as follows:
Share capital—ordinary, par value €10; authorized 30,000 shares; issued and
outstanding 9,000 shares € 90,000
Share premium—ordinary 116,000
Retained earnings 174,000
Total equity €380,000
On March 31, 2019, Arndt declared a 10% share dividend, and accordingly 900
additional shares were issued, when the fair value was €18 per share. For the
three months ended March 31, 2019, Arndt sustained a net loss of €32,000.
The balance of Arndt’s retained earnings as of March 31, 2019, should be
a. €125,800.
b. €133,000.
Answer: b
c. €134,800. 174000 – 10*900 – 32000 =
d. €142,000. 133000
15-88 LO 3
 Additional Exercise 1
HKUST recently hired a new accountant with extensive experience in accounting for
partnerships. Because of the pressure of the new job, the accountant was unable to
review what he had learned earlier about corporation accounting. During the first month,
he made the following entries for the corporation’s ordinary shares. On the basis of the
explanation for each entry, prepare the entries that should have been made for the
ordinary share transactions.

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 Additional Exercise 2
The ordinary shares of SBM are currently selling at $110 per share. The
directors wish to reduce the share price and increase share volume prior to a
new issue. The per share par value is $10; book value is $70 per share. Five
million shares are issued and outstanding.

1. Prepare the necessary journal entries assuming that the board votes a 2-
for-1 share split.
2. Prepare the necessary journal entries assuming that the board votes a
100% share dividend.
3. Briefly discuss the accounting and securities market differences between
these two methods of increasing the number of shares outstanding.

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 Additional Exercise 3
The following data were taken from the statement of financial position accounts of
Megabox Kwun Tong on December 31, 2022.
Current Assets $540,000
Investments $624,000
Share Capital—Ordinary (par value $10) $600,000
Share Premium—Ordinary $150,000
Retained Earnings $840,000

Prepare the required journal entries for the following unrelated items.
1. A 5% share dividend is declared and distributed at a time when the market price of
the shares is $39 per share.
2. The par value of the ordinary shares is reduced to $2 with a 5-for-1 share split.
3. A dividend is declared January 5, 2023, and paid January 25, 2023, in bonds held as
held for collection investment. The bonds have a cost of $90,000 and a fair value of
$125,000.
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 Additional Exercise 4
DOJE had the following equity as of January 1, 2022.
Share capital—ordinary, €5 par value, 20,000 shares issued – €100,000
Share premium—ordinary – €300,000
Retained earnings – €320,000
Total equity – €720,000
During 2022, the following transactions occurred:
⚫ Feb. 1 DOJE repurchased 2,000 treasury shares at a price of €19 per share.
⚫ Mar. 1 800 shares of treasury shares repurchased above were reissued at €17 per share.
⚫ Mar. 18 500 shares of treasury shares repurchased above were reissued at €14 per share.
⚫ Apr. 22 600 shares of treasury shares repurchased above were reissued at €20 per share.

1. Prepare the journal entries to record the treasury share transactions in 2022, assuming
DOJE uses the cost method.
2. Prepare the equity section of the statement of financial position as of April 30, 2022. Net
income for the first 4 months of 2022 was €130,000.
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 Suggested End-of-Chapter Exercises

• P15.5
• P15.7
• P15.8

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 Attention!

Please do NOT distribute the slides or post

them in public websites without the instructor’s
permission. Thank you.

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